United States: FinCEN Proposes New Rule Requiring Anti-Money Laundering Programs For Registered Investment Advisers

On August 25, 2015, the Financial Crimes Enforcement Network (FinCEN) issued a Notice of Proposed Rulemaking (NPRM) that would define investment advisers registered (or required to be registered) with the Securities and Exchange Act (Registered Investment Advisers), including those that manage private funds commonly known as "hedge funds," "venture capital funds" and "private equity funds," as "financial institutions" under the Bank Secrecy Act (BSA).  In the NPRM, FinCEN states that "investment advisers have an important role to play in safeguarding the financial system against fraud, money laundering, terrorist financing, and other financial crime."¹  The NPRM proposes requiring investment advisers to establish anti-money laundering programs and abide by most of the BSA's recordkeeping and reporting requirements, including the requirements to file Currency Transaction Reports (CTRs) and Suspicious Activity Reports (SARS).  In the NPRM, FinCEN has delegated first-line authority to examine for compliance to the Securities and Exchange Commission (SEC) as it has with registered broker-dealers.²

The NPRM solicits responses to more than 30 specific questions spanning multiple topics and is open for comment for 60 days.  The NPRM proposes requiring Registered Investment Adviser compliance with any final rule within 6 months of its effective date.³

While many investment advisers have already voluntarily implemented an anti-money laundering (AML) program on their own initiative, to satisfy the requirements of counterparties, or to allow broker-dealers to rely upon them for part of the broker-dealer's AML program (subject to compliance with the requirements of a SEC No-Action Letter), this NPRM is significant for several reasons, including:  (1) the long pending uncertainties and inconsistencies in the application of the BSA's AML program requirements to investment advisers; (2) the proposed scope of the affirmative obligations imposed; and (3) the number of significant issues left unresolved.

A. FinCEN's Previous Attempts and Changed Landscape

This is not the first time that FinCEN has tried to impose compliance program requirements on investment advisers.  On May 5, 2003, FinCEN published a notice of proposed rulemaking (the "2003 Proposed Rulemaking") that would have required Registered Investment Advisers and a large percentage of unregistered investment advisers to private funds to establish AML programs.⁴  No action was taken for five years, until the 2003 Proposed Rulemaking was withdrawn in 2008.⁵

In recent years, however, senior officials at FinCEN and the Department of the Treasury have been devoting efforts to expand and enforce the BSA's reach to detect and prevent money laundering⁶, specifically focused on non-bank institutions.⁷ It is therefore not surprising that FinCEN is renewing its efforts to bring investment advisers into the BSA fold.  When the 2003 Proposed Rulemaking was published, the financial crimes enforcement world was still adjusting to the changes to the BSA regulatory and potential enforcement landscape brought by the USA PATRIOT Act, which went into effect in 2001.⁸  Over a decade later, and in the wake of the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act),⁹ FinCEN is more comfortable with the BSA's requirements, and with the tools for enforcement it has developed.

B. The Proposed New Rules

The NPRM addresses three major topics: (1) the definition for "investment adviser" for purposes of the proposed rule; (2) the scope of the AML program requirements to be imposed; and (3) the specific reporting and record keeping requirements to be imposed.  The following is a summary of the key points contained in the NPRM.

1. Definition of Investment Advisers

• The NPRM proposes including a definition of "investment adviser" to section 1010.100(nnn) and defining it as:
  "[a]ny person who is registered or required to register with the SEC under section 203 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-3(a))."¹⁰
• "The proposed definition relies on terms and definitions used in the [Investment Advisers Act of 1940] and in the SEC's regulations implementing the Advisers Act."¹¹
• This generally means "large" investment advisers, or investment advisers with $100 million or more in regulatory assets under management.¹²
• The proposed definition includes both primary Registered Investment Advisers and sub-advisers¹³ encompassing:
• • dually-registered investment advisers and advisers affiliated with, or that are subsidiaries of, entities required to establish AML programs,
  • certain foreign investment advisers,
  • investment advisers to registered investment companies,
  • financial planners and pension consultants, and
  • entities that provide only securities newsletters and/or research reports.¹⁴
• FinCEN reserves the right for future rulemaking that may encompass other types of investment advisers, such as state-regulated investment advisers, or investment advisers exempt from SEC registration.¹⁵

2. Proposed AML Program Requirements

• Requires development and implementation of a written AML program "reasonably designed to prevent the investment adviser from being used to facilitate money laundering or the financing of terrorist activities..."¹⁶
• The program must cover all of a Registered Investment Adviser's activities, including advisory services that do not include the management of client assets, subadvisory services, and advisory services provided to real estate funds.¹⁷
• The NPRM expects investment advisers to analyze the money laundering and terrorist financing risks posed by a particular client that maintains an account with the adviser by using a risk-based evaluation of relevant factors.¹⁸
• The NPRM acknowledges that certain types of advisory clients may present different risks and provides limited discussion on (a) non-pooled investment vehicle clients such as individuals and institutions; (b) registered open-end fund clients such as mutual funds (lower money laundering risks); (c) registered closed-end clients (lower money laundering risks), (d) private fund clients and unregistered pooled investment vehicles (potentially lower money laundering risks), and (e) wrap-fee programs.¹⁹
• In cases where investment advisers are dually registered with the SEC as broker-dealers and investment advisers, the NPRM contemplates permitting either one enterprise-wide program or multiple or separate programs for each activity.²⁰
• Some elements of the compliance program may be contractually delegated to certain third-party service providers, provided the investment adviser will remain fully responsible for the effectiveness of the program.²¹
• All programs must contain the four minimum elements of any BSA program, which include: (1) a written program designed to detect and prevent the facilitation of money laundering;²² (2) independent testing of the program;²³ (3) designations of a person responsible for implementing and monitoring the program;²⁴ and (4) ongoing training of appropriate persons within the organization on the program.²⁵

3. SAR Reporting and Other Reporting/Recordkeeping and Information Sharing Requirements

• Registered Investment Advisers will be required to report suspicious activity (through filing of a SAR) that is conducted, or attempted to be conducted through an investment adviser and involves at least $5,000 (including in aggregate) in funds or other assets.²⁶
• The NPRM would require that a Registered Investment Adviser "evaluate client activity and relationships for money laundering risks and design a suspicious transaction monitoring program that is appropriate for the particular investment adviser in light of such risks."²⁷
• • Note: The NPRM as proposed does not permit Registered Investment Advisers to share SARs within their corporate organization structure.  The NPRM states that FinCEN is aware that this may be in conflict with fulfilling its BSA obligations or "effective enterprise-wide BSA compliance" and specifically requests comments on the advisability of this limitation.²⁸
• Investment advisers would no longer be required to file Form 8300 for the receipt of cash or negotiable instruments in excess of $10,000.²⁹
• In lieu of the Form 8300 requirement, Registered Investment Advisers would be required to file CTRs for the transfer of more than $10,000 in currency by, through or to the investment adviser. ³⁰
• Investment advisers would be subject to the "travel rule" which requires certain information, such as name, address and other information about the transmitter and the transaction, to be obtained/retained and "travel" with  transmittal orders that equal or exceed $3,000, subject to certain exceptions.³¹
• Registered Investment Advisers would be subject to the information sharing requirements of 314(a) and 314(b) of the USA PATRIOT ACT.³²

C. Requests for Comments and Unanswered Questions

FinCEN seeks comments on essentially all aspects of the NPRM.  The NPRM contains approximately 30 specific requests for comments covering numerous  topics.  The requests for comment range from seven questions devoted specifically to the definition of "investment adviser," to the proposed minimum requirements for an effective AML program, to the proposed suspicious activity reporting rule, to FinCEN's calculations for economic impact on imposing the requirements on this industry.

Although the NPRM proposes only to include Registered Investment Advisers within the definition of "financial institution," it expressly leaves the door open for future rulemakings to include other types of investment advisers, "such as state-regulated investment advisers or investment advisers that are exempt from SEC registration."³³  Specific questions posed include:  (i) whether there are classes of Registered Investment Advisers that should not be included in the definition; (ii) to what extent mid-sized, small, State-registered, and foreign private investment advisers that are not within the definition pose risks that would justify including them; and (iii) whether there are other types of investment advisers that do not meet the definition, such as "exempt reporting advisers" that are advisers to private "hedge funds", "venture capital funds" and "private equity funds," that should be included.

These questions are particularly significant because they raise multi-faceted issues as to how the amendments to the Advisers Act that were made by the Dodd-Frank Act and implemented by SEC regulations³⁴ should be reconciled with the AML risks addressed in the proposed rulemaking.

In addition to the specific requests for comment, the NPRM raises many other unanswered questions and areas subject to interpretation, including the lack of an explicit requirement that any third-party service provider that is relied upon for an AML compliance function itself be subject to the AML program rule, and what additional consequences there may be, if any, for failing to register with the SEC in the first instance.

As noted in the introduction, the NPRM provides a 60-day period during which FinCEN will accept public comments.  All interested parties, including and especially potentially covered investment advisers, should be prepared to review, evaluate, and submit comments on the proposed new rules, either through counsel, a trade group, or on their own behalf – in addition to preparing to implement or evaluate any existing compliance programs.

Footnotes

^{1  NPRM at 8.}

^{2 NPRM at 16.}

^{3  NPRM at 38.}

^{4 Financial Crimes Enforcement Network; Anti-Money Laundering Programs for Investment Advisers, 68 Fed. Reg. 23646, at 23648 (proposed May 5, 2003).}

^{5 Withdrawal of the Notice of Proposed Rulemaking, 73 FR 65569 (Nov. 4, 2008).}

^{6  Jennifer Shasky Calvery, Director, FinCEN, Remarks at Securities Industry and Financial Markets Association Anti-Money Laundering and Financial Crimes Conference, (Feb. 27, 2013), available at http://www.fincen.gov/news_room/speech/pdf/20130227.pdf ; David Cohen, Under Secretary, Dept. of Treasury, Remarks at the ABA Money Laundering Enforcement Conference (Nov. 10, 2014), available at http://www.treasury.gov/press-center/press-releases/Pages/jl2692.aspx.} 

^{7 As demonstrated by the recent enforcement actions, issuance of guidance, or requests for comments with respect to numerous types of non-bank financial institutions, such as insurance companies and non-bank residential mortgage lenders, money services businesses engaged in the virtual or digital currency space, and casinos to name a few.}

^{8 Pub. L. No. 107-56, Title III,  352, 115 Stat. 272, at 322 (2001); 31 U.S.C. § 5318(h).}

^{9 12 U.S.C. 5301} 

^{10 NPRM at 12.}

^{11 Id.}

^{12 NPRM at 13-14.}

^{13 Id. at 14-15.}

^{14 NPRM at 15.}

^{15 Id.}

^{16 Section 1031.210(a)(1).}

^{17 NPRM at 25.}

^{18 NPRM at 36.}

^{19 NPRM at 27-32.}

^{20 NPRM at 32-33}

^{21 NPRM at 34.}

^{22 Section 1031.210(b)(1).}

^{23 Section 1031.210(b)(2).}

^{24 Section 1031.210(b)(3).}

^{25 Section 1031.210(b)(4).}

^{26 NPRM at 40; proposed section 1031.320(a).}

^{27 NPRM at 42.}

^{28 NPRM at 39-40.}

^{29 NPRM at 17-18}

^{30 Id.}

^{31 NPRM at 20-21.}

^{32 NPRM at 49.}

^{33 NPRM at 12.}

^{34   The Impact of the Dodd-Frank Act on Advisers to Private Funds, Orrick Client Alert, June 6, 2011.}

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.